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Detailed Glossary
| Trading |
Location | ||
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Location is one of the key dimensional attributes of all physically settled, and many financially settled, trades Detail Location is usually a description of where the delivery a of a trade will take place Although this sounds fairly straightforward, in practice location means different things for different commodities. This is because the delivery location simply defines the lowest level of distinguishable information about the delivery, and this lowest level varies with the commodity So let's look at some commodity locations to see what this means: Natural Gas The location of the majority of gas trades in the UK is the NBP The NBP isn't even a real location, it describes the UK-wide gas pipeline network called the National Balancing Point On the day of delivery, a seller of gas has an obligation to deliver gas at the NBP The seller may deliver it from any other location that is physically connected to the NBP, it doesn't matter where that is. The buyer may take delivery to any other location that is physically connected to the NBP Gas traded locations such as the NBP are called hubs. Some hubs require the buyer and seller to identify the physical connection point of delivery - these are physical hubs Other hubs, like the NBP do not require the buyer and seller to identify the connection point - these are virtual hubs | ||
Market | ||
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In Energy Trading a Market describes a standardized trading environment for a commodity and a geographic zone The geographic zone is not necessarily the delivery location, but usually determines the valuation of the traded commodity For example API#2 is a market based on the published index for coal in the Amsterdam, Rotterdam and Antwerp (ARA) location; a trade may deliver coal to a port in France but still be part of the API#2 market Detail A market combines attributes of commodity and location and may have an associated calendar and business rules, which provide defaults for any trade associated with the market Some delivery locations are also markets, so far example NBP is a gas location and also market Note the similarity and difference to a Master Agreement which has similar attributes | ||
Market Maker | ||
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A market maker quotes prices at which they are prepared to buy or sell a commodity - usually on an Exchange or with a broker Detail A price at which a party is prepared to buy is called a Bid (they bid to buy the commodity) A price at which a party is prepared to sell is called an Offer (they offer to sell the commodity) By offering continuous bid and offer prices, Exchanges encourage traders to take positions, secure in the knowledge that they can always close them out. This is another way of saying that they improve the liquidity of the market There are usually benefits to the market makers themselves from offering this service | ||
Master Agreement | ||
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When two parties execute a trade between themselves they specify the terms of the trade: Price, Volume, Location, timing etc. But in order to successfully manage the trade's delivery and settlement a lot more information needs to be available than is captured in the trade details, such as when payment is due, who needs to notify a TSO etc. This additional detail is held in a Master Agreement Each trade that is executed is regulated by a Master Agreement Detail Master Agreements exist to cover various sorts of trade, for example the UK standard gas and power Master Agreements : GTMA (Grid Trading Master Agreement) covers UK power trading, complete with all the details of notification NBP97 (Short Term Flat NBP Trading Terms and Conditions Ref. NBP 1997) covers natural gas trading at the NBP complete with details of nomination Master Agreements may reference other Master Agreements - ISDA for example is an organization that is aiming to offer master agreements that unify trading, for example at the NBP and at TTF Master Agreements are themselves referenced by bilateral trading agreements, which are agreements set up by pairs of potential trading partners to specify which Master Agreements will be used for different products and instruments, and usually cover other arrangements such as netting, collateral etc. Master Agreements may have schedules or annexes that define additional terms, or override terms in the main agreement Bilateral Master Agreements may have additional schedules that define variations to the standardized master agreements A Confirmation, as well as confirming the trade details, also confirms the master agreements that regulate the trade, and may itself contain exceptions or variations from the general bilateral terms
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Maturity | ||
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Generally a financial trading term used sometimes in the commodities trading market to mean the expiry or expiration date - particularly futures contracts Detail A classic energy futures contract has a single date that represents: The last date it may be traded The date it is cascaded to shorter contracts The date it is completely settled (if a financial futures contract) This date is usually called the expiry date, and therefore it is also the maturity date However it is possible that the contract may continue to be financially settled after the last date it may be traded - in this case the maturity date is usually the completion of financial settlement Be careful when looking at contract details - the terms are used inconsistently between exchanges and brokers... | ||
Megawatt | ||
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A Megawatt is a measure of energy per unit time
Abbreviation is MW Not to be confused with MWh Detail In energy trading we usually refer to electricity as power In physics power is energy per unit time
Gas and power trades are often specified in Megawatts because they have a continuous flow rate However energy trades are priced in terms of energy (e.g. €45.3/MWh) so we need to be able to calculate the number of MWh of the trade or delivery period This is easy if we use the equation: 1 MWh = 1 MW flowing for one hour and simply remember this Megawatt.hours = Megawatts x hours or MWh = MW x hours Just like the speed of a car: you can't meaningfully add two values in Megawatts at different times - what does it mean to add two speeds together at different points on the Motorway? If I drive 60 mph for 10 minutes, then 72 mph for the next 5 minutes, does the number 132 mph mean anything? (No!) If I flow 10 MW one day and 20 MW the next day, the value 30 MW has no meaning you can meaningfully add two values in Megawatt hours at different times If I drive 10 miles in the first ten minutes, then 6 miles in the next five minutes, then I have driven 16 miles in total If I flow 240 MWh one day and 480 MWh the next day, then I have flowed 720 MWh over the two days you can't normally price something in Megawatts - a toll road makes you pay per mile, it doesn't matter how fast you went For clarity: 1 Watt = 1 joule per second; 1 W = 1 j/s 1 kilowatt = 1,000 Watts; 1 kW = 1,000 W 1 Megawatt = 1,000 kilowatts; 1 MW = 1,000 kW 1 Gigawatt = 1,000 Megawatts; 1 GW = 1,000 MW 1 Terawatt = 1,000 Gigawatts; 1 TW = 1,000 GW | ||
Megawatt hour | ||
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A measure of energy - abbreviated to MWh Equivalent to one Megawatt of power flowing for one hour Detail In physics Power = Energy per unit time, e.g. joules per second this can be thought of as an energy flow rate it follows that Energy = Power * time think of energy (MWh) as the equivalent of distance (miles or kilometres), and power (MW) as the equivalent of speed (mph or kph) Electricity (confusingly also normally called power) and gas trades are often described in terms of a rate of energy, e.g. Megawatts, or therms per hour However energy trades are priced in terms of energy (e.g. €45.3/MWh) so we need to be able to calculate the number of MWh of the trade or delivery period This is easy if we use the equation: 1 MWh = 1 MW flowing for one hour and simply remember this Megawatt.hours = Megawatts x hours or MWh = MW x hours Just like the speed of a car: you can't meaningfully add two values in Megawatts at different times - what does it mean to add two speeds together at different points on the Motorway? If I drive 60 mph for 10 minutes, then 72 mph for the next 5 minutes, does the number 132 mph mean anything? (No!) If I flow 10 MW one day and 20 MW the next day, the value 30 MW has no meaning you can meaningfully add two values in Megawatt hours at different times If I drive 10 miles in the first ten minutes, then 6 miles in the next five minutes, then I have driven 16 miles in total If I flow 240 MWh one day and 480 MWh the next day, then I have flowed 720 MWh over the two days you can't normally price something in Megawatts - a toll road makes you pay per mile, it doesn't matter how fast you went | ||
Offer | ||
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An Offer is a type of Order; a trader offers to sell a product or commodity at the Offer price Detail The trader offers a product for sale at a particular price Offers are normally submitted to a Broker or an Exchange If an offer is matched by a subsequent bid by another party, then a trade is executed If the offer matches an already quoted bid then a match is made and a trade is executed See also Bid | ||
Option | ||
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At its simplest an energy option is an instrument that gives the buyer the right, but not the obligation, to buy, or to sell, a commodity at a specified price at some point in the future.
More complex options may be financially settled, the payout being dependent on some condition(s) being met, and varying with some observable value(s) at the time of exercise
There is usually a single non-refundable payment made by the buyer of the option (the holder) to the seller of the option (the writer) - this is the option premium
Detail
First, let's try and categorize the different types of options we'll come across, and then describe each in detail, starting with the simplest:
1. Vanilla options - so called because they are a standard "flavour", which may themselves be divided into:
a) Simple physical options - already briefly described above, these include European and American options
b) Financially settled options - these pay out if some measurable, usually a published index, meets some specified criteria. The payout varies with this or other measurables. This category includes Asian options
c) Simple combination options - not strictly different types of options, but traders frequently combine simple options to tailor risk and payout to their circumstances
2. Exotic options - in contrast to vanilla options, exotic options are non-standard, usually complex and are designed to offer, or conceal, a combination of characteristics
Let's look at the simpler types in more detail
Simple physical options
Simple physical options may be thought of as an option to execute a Forward Contract. Indeed, if the option is exercised it effectively becomes a Forward Contract
When the option is traded the following terms are agreed:
Financial options Financial options pay out a cash amount if they are in the money - the cash payout usually being the difference between a fixed strike price, and some variable observable, usually the published price of a energy commodity or product Spread options and options on swaps (swaptions) are types of financial options Asian options are financial options which pay out on the average price of an underlier over the delivery period - assuming they are in the money | ||
Order | ||
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An Order is an instruction sent to an Exchange or a Broker to execute a trade unconditionally, or when or if specific criteria are met Detail A Market Order is the simplest, unconditional, type of Order. It is a simple instruction to buy or sell a specific volume of a product or commodity to be executed immediately at the best price available A Limit Order is an instruction to buy or sell a specific volume of a product or commodity if the price of execution is at or better than the Limit Price specified with the Order An Order may combine, in a single instruction, a number of transactions that are required A Fill or Kill Order requires all transactions to be carried out, or none. Partial execution is not permitted Exchanges handle all types of Order internally Other organizations or parts of organizations may accept combination Orders, and then route different parts of the Order to different Exchanges, Brokers or other parts of the organization For example a large trading organization may have several desks issuing Orders that overlap. An internal order routing capability matches internal orders as far as possible before routing the unmatched orders to external organizations (brokers or exchanges) Bids and Offers are types of Order
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